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Profit leakage is a loss of profits due to the difference between actual prices and prices on invoices. Businesses set target prices and figure their financial projections based on those prices. That means their projected profits depend on those prices. Gross profit leakage occurs when a business does not actually get the prices it is recording in its sales records. Examining the reasons for profit leakage can help you stop it.

Use a Price Waterfall

A price waterfall is the measure of actual net prices received against defined target prices. This requires that staff gather data on monies received and costs. The people engaged in the price waterfall project must synthesize the data on net prices and compare it to target prices. This will expose your gross profit leakage.

List Price

The first thing your examining staff should collect is the list price for each item sold. This is the price your company actually advertises to customers. Every item should have a list price. If some do not, they must be established immediately, so that examiners have a benchmark to measure prices by.

Invoice Price

The invoice price is the amount on the actual invoice. It may reflect discounts and rebates offered to the customer. One of the first places to look for gross profit leakage is in the discrepancy between list prices and invoice prices.

Net Price

The net price comes from the invoice price minus any off-invoice discounts. Though the invoice may list discounts, there may be other discounts that were offered but not included in the invoice. This is the net price.

Pocket Price

The pocket price is the amount the company received after customer-related expenses and customer-specific costs, which include freight, cost of rush orders and cost of special orders. In addition, a per-unit cost should be calculated for these expenses: sales team, customer service personnel, training and promotions. The pocket price is the net price minus expenses.

Pocket Prices vs. List Prices

If the pocket prices are significantly less than the list price, this indicates gross profit leakage. An examination of each of the different prices will identify exactly where the leakage is occurring. Management can then move to reduce the amount the company is losing in that area.

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About the Author

Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.

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Johnston, Kevin. "The Meaning of a Gross Profit Leakage." Small Business - Chron.com, http://smallbusiness.chron.com/meaning-gross-profit-leakage-13105.html. Accessed 21 January 2019.

Johnston, Kevin. (n.d.). The Meaning of a Gross Profit Leakage. Small Business - Chron.com. Retrieved from http://smallbusiness.chron.com/meaning-gross-profit-leakage-13105.html